Quite often, we're mystified at how Apple (AAPL), with its incredible revenue and earnings growth, has so much trouble holding to a large earnings multiple, while stocks such as Amazon (AMZN), with slower revenue growth and falling earnings, can command such an earnings multiple premium.
As I write these lines, Apple trades at 15 times 2012 estimated earnings, and this is without excluding its huge cash hoard. These earnings are estimated to grow 60.5% over the same period last year (year ending on September 2011), while revenues are expected to grow 44.8% year on year as well.
As for Amazon.com, it trades at 352 times 2012 estimates earnings. These earnings are estimated to fall 48% from 2011, while revenues are expected to grow 30.6%.
So basically, Apple grows revenues more, grows earnings more (indeed, Amazon's are falling) and yet trades at a multiple that's more than 20 times lower than Amazon's!
What keeps Apple's multiple so low?
In the past, I've explained how Apple today is mostly about the iPhone, with the iPhone representing 2/3rds to 3/4ths of its earnings. This can be a partial explanation for why the market consistently attributes a lower earnings multiple to Apple. After all, many other mobile phone leaders of the past lost that position, and if the same happened to Apple, the resulting company would warrant a much lower valuation.
This motive is sensible. However, there's something else rather more mechanical about it. Back on September 18, Mebane Faber from World Beta put together a list of the funds where Apple constituted the largest holdings (the source being these fund's 13-F filings). The list was as follows:
Now, in a world used to sub-10% allocations and diversification, there exposures seem really aggressive. So aggressive they seem, that these funds get the distinction of having the highest weights geared towards Apple.
The problem for Apple
This, however, presents a problem. Apple's market capitalization is so large, that it also represents an awfully large weight in the indexes, namely in the Nasdaq 100. Indeed, this weight was so large that Nasdaq had to artificially reduce it back in April 2011, taking it from 20.49% to just 12.33%. However, Apple continued on upwards, and using the PowerShares QQQ ETF (QQQ) as a proxy, Apple's weight is now back to around 19.7%.
This explains Apple's earnings multiple problem. Apple is being underweighted even by its most aggressive holders! Of the table I presented, only a single holder is over Apple's weight in the Nasdaq 100.
This is less of a problem for those funds that might track the S&P as a benchmark, for there Apple has a weight around 5%. But this still shows how funds trying to invest in growth, which will be more likely to use as a benchmark the Nasdaq 100, are driven to underweight Apple by its sheer size when compared to other alternatives.
And it should also be kept in mind that even Apple's 19.7% present weighting is itself artificial, after Nasdaq's reduction. Its market capitalization would have led to an even higher weighting! So a fund weighting Apple at 19.7% would, in fact, be underweighting it when compared to other stocks whose weights were not driven down or were even driven up artificially.
In a way, Apple is the victim of its own success. The huge market capitalization it has attained has driven its weight on capitalization-weighted indexes to such heights that growth-oriented managers, even while positive on Apple's prospects, hesitate to weight the stock at the same levels in the funds they manage. The end result is chronic underweighting leading to lower valuations for Apple stock, something which is evident even from reading the list of the most aggressive Apple holders.